Composites show good mettle

A growth industry without bubble-like tendencies is a rarity in the current climate, but the manufacture of composite materials could prove a near-run thing.
 
Composite materials, made from two or more constituents with different properties, provide huge weight and strength advantages over traditional metals for high performance machinery, and are increasingly used in the manufacture of aircraft and wind turbines, not to mention marine, medical and sporting applications where these dual qualities are important. The rising price of oil and the need for alternative energy are long-term one-way trends underpinning demand that is expected to boom for a decade and beyond.

Composites have been around since the 1940s - New York-listed Owens Corning (OC) developed a fiberglass car in 1945 -  but in the early days they had a history of separating on impact or repeated stress. The best known failure occurred in 2003 when the carbon-fiber wing of Space Shuttle Colombia fractured during take-off, causing it to break up when it re-entered the earth's atmosphere, killing seven astronauts.

Technology has since moved on, and carbon-fibre composites are now

used widely in commercial and military aircraft. The lightness helps reduce fuel consumption, critical as the threat looms of higher tax on aviation fuel. Composite materials also improve passenger comfort by making it possible to keep the air more moist than is possible in traditional aluminium planes, and also to boost  the air pressure in the cabin to an equivalent altitude of 6,000 feet, rather than the current 8,000 feet.
 
The new Boeing 787 Dreamliner structure will be composed of over 50% composites, and, according to the manufacturer, will burn 20% less fuel than its predecessor, the Boeing 767, and 27% less than the Airbus A340-300. So far Boeing has won hands down in the contest against EADS in obtaining orders for next-generation commercial aircraft, and although it may seem counterintuitive in current economic climes, there is no visible recession in new plane orders, which currently stand at nearly 3,800 worldwide.

Composite manufacturer Umeco (UMC) supplies New York-listed Boeing (BA), Airbus and London's BAE Systems (BA-), and the shares been much talked up recently. Around 70% of Umeco's business is derived from the civil aerospace market, but it also has growing order books for wind turbines parts and a fast-growing supply chain management business, which recently announced a five-year extension to 2015 of a supply deal with Rolls-Royce. Late last year it bought two specialists in the composite market, Primco, a 40-year-old Mancunian company, and JD Lincoln, based in California.

The company trades  on a  modest 12 times forward PE but the shares are volatile and three directors sold chunks of their shareholdings in June, including CEO Clive Snowdon.
 
One issue is that Dreamliner has been beset with problems; only last week an engineer error emerged that could set the schedule back further. The original estimate of March had already been delayed to the third quarter, and the latest incident could be crucial to the schedule because although the hole has been mended, the damaged craft was to have taken a key role in the testing of the new aircraft.
 
If Dreamliner misses its 2008 delivery deadline and fails to perform as its engineers promise, then the order book will diminish fast. Some airlines may also not be sufficiently profitable to support their orders, many of which were made in a more buoyant economic climate.

Escalating markets

But composites are not just for aircraft; other markets are also escalating. In wind power generation, composites have enabled blade sizes to grow to giant proportions. Wind turbine manufacturers produced over 200,000 metric tonnes of finished blades last year, making wind turbine blades one of the largest applications of engineered composites. 2007's volume was 38% higher than 2006 and almost double 2005's output.

Half of Swiss company Gurit's market is related to wind power and it recently opened a subsidiary in China to take advantage of the country's focus on this energy source. China's blueprint is that its wind-driven generators should generate 5,000 MW by 2010 and grow six-fold by 2020. Both Vestas and Airbus, important clients of Gurit, have operations located in the Tianjin Coastal District region.

In June, Gurit's shares surged 4% on an announcement that it had won a 200 million Swiss francs four-year supply agreement from EADS but in fact this was a renewal of an existing contract, albeit one that has cemented its position as a key supplier to the French airline and secures good visibility on an important line of its P&L. Last week the shares declined after Merrill Lynch analysts pointed out this misconception and downgraded its recommendation to 'underperform', saying the stock looks fully valued.

Hexcel Corporation (HXL) - listed in New York - introduced composites to the wind turbine industry over 15 years ago and will open a new facility in Tianjin in October 2008 to meet accelerating demand. Hexcel is a diversified play on the sector, and the only composites supplier that makes an almost complete range of Fibre Reinforced Matrix technologies together with honeycomb, adhesives and engineered products.

The space and defence markets have historically been innovators in advanced structural materials, playing a part for instance in the development of stealth technologies for military aircraft and as launch vehicles for spacecraft and satellites, and both markets are still important to Hexcel.

One of the shovel-makers in this industry is Hampson Industries (HAMP), which makes aerospace composite tooling. The company has recently completed a £65m share placing to fund the acquisition of Odyssey and Global Tooling Systems, two US tooling suppliers for next-generation aircraft, including Dreamliner and the F-35 Joint Strike Fighter. The push into high-margin, high-growth aerospace composite component and tooling systems manufacture is expected to increase Hampsons turnover by about 50% to more than £220 million. Pre-tax profits rose nearly 50% to £9.2 million in the year to March, and the company, which has been considered highly geared in the past, is steadily paying down its debt.
 
Owens Corning has been a leading player in the composite market for decades, making fiberglass for wind power blades. It also has high hopes for its insulation manufacture business as a cheap way to improve a home's energy efficiency, a feature that could soon start to impact resale values. However, its roofing business has struggled and it has huge exposure to the  residential property market. Hedge fund Harbinger Capital Partners has purchased $57.46 million of Corning's shares in a bet  on their recovery, but at current levels ($21.79) the strategy has yet to pay off.